Green bonds’ appeal rooted in finance as well as ethics

By allocating assets towards an ethical purpose, investors in green bonds are funding the transition away from fossil fuels to low-carbon, energy-efficient projects.

Using debt capital markets to fund renewable energy initiatives and tackle climate change is not a new concept, but it is one gaining mainstream acceptance at a rapid rate. The green bond market has been growing rapidly in size and sophistication over the past few years – and shows no signs of slowing.

Total annual issuance grew from $5 billion in 2011 to more than $49 billion at the end of 2016, and we believe the global market could exceed $250 billion annually in the next couple of years. But will potential regulatory change under a Trump administration stymie growth?

The short answer is no. While some investors are no doubt concerned about the potential for a change in policy, the reality is that there is only so much Trump can do at the national level. Moreover, much of the growth in the sector has been supported at a state level, which is unlikely to change.

Trump’s public declaration that he may withdraw the US from the Paris Agreement on global warming must be seen within a broader political context. The impetus for change and the drive towards clean energy development in the US is too well-entrenched to falter because of Trump’s comments. Even if the US does withdraw from the agreement, this would not significantly affect the global market, given the number of arguably more important signatories.

Europe, Canada, India and China, all signatories to the Paris agreement, account for a far larger percentage of green bond issuance globally than the US. As at December 30, 2016, France accounted for 16 per cent of the market, followed by Germany at 13 per cent and the Netherlands at 13 per cent. The US made up just 8 per cent. And with major global cities such as Beijing, Delhi and Mexico City imposing travel bans due to the high levels of pollution, the global desire to address climate change and global warming remains strong. In fact, even Saudi Arabia is engaged in a program aimed at encouraging a diversification away from oil.

Competition, investor demand drive green bond issuance

Green bonds are increasingly being used to fund many environmental projects outside of traditional renewable energy solutions. These include programs to improve energy efficiency, clean transport, water sustainability, waste management and biodiversity. At the same time, successful companies understand that they must innovate to remain competitive. For many, sustainable, renewable energy is part of that innovation.

As renewable energy becomes less expensive, companies willing and able to adapt to new environments will not only be more sustainable, but also more competitive. Inevitably, these companies will be able to deliver a higher financial performance relative to their peers.

Southern Power, the US’s major wholesale clean energy provider, is a case in point. Its business model includes selling electricity generated by clean-energy assets to customers ranging from municipalities to investor-owned utilities and electricity co-operatives.

When the Southern Power green bond was launched in November 2015, the credit spread over US Treasuries was in line with the average for the sector, at 185 basis points. As at mid-February 2017 however, Bloomberg data shows the green bond index’s spread had tightened by 34 basis points, while the spread for the Southern Power Green bond had tightened by 69 basis points, double the sector average. There are many factors that affect the financial performance of companies, but in general terms, a tightening of the spread over Treasuries is a clear indication of investor confidence.

A sustainable, growing funding option

As green bonds continue to gain market share and acceptance, the sector will continue to grow exponentially, regardless of who is in the White House.

And why not? It’s not just a win-win, it’s a win-win-win. For the issuer, it’s an attractive finance option; for investors, it offers a strong return and yield profile, with transparency about where their money is going. And because it’s a green funding initiative, it’s a win for everyone on the planet.

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Investment Magazine provides in-depth, monthly analysis of trends and developments for all the businesses in which superannuation funds engage‚ including asset allocation, investment manager selection, custody and fund accounting, member administration, group insurance and compliance.